TOWARD A US-CHINA INVESTMENT TREATY. February 2015 PIIE Briefing 15-1

TOWARD A US-CHINA INVESTMENT TREATY February 2015 PIIE Briefing 15-1

CONTENTS INTRODUCTION 3 1 THE CHINA-JAPAN-KOREA TRILATERAL INVESTMENT AGREEMENT: IMPLICATIONS 6 FOR US POLICY AND THE US-CHINA BILATERAL INVESTMENT TREATY JEFFREY J. SCHOTT AND CATHLEEN CIMINO 2 STATE-OWNED ENTERPRISES AND COMPETITION POLICY: THE US PERSPECTIVE 16 SEAN MINER AND GARY CLYDE HUFBAUER 3 ROLE OF A BILATERAL INVESTMENT TREATY IN INCREASING TRADE IN 24 SERVICES BETWEEN CHINA AND THE UNITED STATES J. BRADFORD JENSEN 4 COMMITTEE ON FOREIGN INVESTMENT IN THE UNITED STATES AND THE 34 US-CHINA BILATERAL INVESTMENT TREATY: CHALLENGES IN MEETING CHINA S DEMANDS GARY CLYDE HUFBAUER, SEAN MINER, AND THEODORE MORAN 5 A BILATERAL INVESTMENT TREATY AND ECONOMIC RELATIONS BETWEEN 41 CHINA AND THE UNITED STATES C. FRED BERGSTEN Copyright 2015 by the Peterson Institute for International Economics. The Peterson Institute for International Economics is a private, nonprofit institution for rigorous, intellectually open, and indepth study and discussion of international economic policy. Its purpose is to identify and analyze important issues to make globalization beneficial and sustainable for the people of the United States and the world, and then to develop and communicate practical new approaches for dealing with them. The Institute is widely viewed as nonpartisan. Its work is funded by a highly diverse group of philanthropic foundations, private corporations, and interested individuals, as well as income on its capital fund. About 35 percent of the Institute s resources in its latest fiscal year were provided by contributors from outside the United States. A list of all financial supporters for the preceding four years is posted at http://piie.com/supporters.cfm.

INTRODUCTION The United States and China are the two largest economies in the world. They are among the world s largest trading nations, and they serve as both the destination and the source of the world s largest flows of foreign direct investment (FDI). Both countries participate in a range of regional economic arrangements on trade and investment in the Asia-Pacific region and other parts of the world. Yet when it comes to direct investment in each other s economies, China and the United States are among the world s underperformers. That situation could change with the successful conclusion of the negotiation of a US-China bilateral investment treaty (BIT). This PIIE Briefing examines prospects for a US-China BIT now that negotiations have revived. Launched in 2008 during the presidencies of George W. Bush and Hu Jintao, the talks faltered after the 2008 election of President Barack Obama, whose economic team had other economic priorities upon taking office at the height of the Great Recession. The Obama administration spent its first years holding internal debates about trade deals that it had inherited. 1 In the same period, they put the US-China BIT talks on hold while the United States revised the terms of what an ideal investment treaty should look like, a document known as the US model BIT. The internal US government review of investment issues was not completed until 2012. US-China BIT negotiations resumed in 2013; the 17th round of negotiations was held in December 2014. The essays in this study focus specifically on recent developments that could inform and possibly set precedents for the investment pact. They also examine issues that pose challenges to a successful negotiation. Given the large economic footprint of both economies, the size of cross-border investment in each other s markets is surprisingly small. US FDI in China in 2012, valued around $54 billion, represented only about 1.2 percent of the $2.2 trillion of total FDI in China. 2 And China accounted for an even smaller share of FDI in the United States. 3 Removing discriminatory investment restrictions via a US-China BIT could yield a significant payoff, not simply as a means of encouraging two-way investment but also as a means of helping resolve investment-related disputes. 4 But getting agreement on such a pact will require reconciling differences regarding the scope and coverage of the prospective pact and addressing the extensive complaints that both have about FDI policies in the other s market. There is ample precedent for the success of investment treaties. Both the United States and China have used BITs over the years to advance their investment relations. Existing pacts have helped reduce policy bar- 1. The US-China BIT negotiation is also a challenge for Obama s policy since it counter poses the administration s objective to open Chinese market with their concerns about adverse US job effects related to FDI outflows. 2. Figures are from US Bureau of Economic Analysis. 3. Sources disagree as to the value of investment in each other s markets. In part, the low stock is due to measurement discrepancies but also due to barriers to investment. See table 2 in the essay by Jeffrey J. Schott and Cathleen Cimino. 4. C. Fred Bergsten, Gary Clyde Hufbauer, and Sean Miner, Bridging the Pacific: Toward Free Trade and Investment Between China and the United States (Washington: Peterson Institute for International Economics, 2014). 3 PIIE BRIEFING 15-1

riers limiting FDI and enhance the investment climate between the partner countries. Put simply, BITs are designed to encourage foreign investment and to establish reciprocal rules for the treatment of firms and protection of investments. The number of BITs globally has now reached more than 2,850. 5 The United States has 41 BITs in force, the majority of which are with developing countries. China has 104 BITs in force, of which 78 are with developing countries and 26 are with developed countries, including Canada, Germany, and the United Kingdom. That said, BITs negotiated by the United States and China differ markedly in terms of the types of investments covered, the rules applied to investment policies, and the enforcement provisions to protect investor rights. For the United States, the 2012 revision of the US model BIT sets out a detailed and broad-ranging template for treaty rights and obligations that US officials expect their partners to undertake and enforce in all bilateral investment pacts. 6 The US model BIT sets a high bar in requiring extensive obligations on investment policies, investor rights and protections that open up meaningful new market access opportunities, and a robust investor-state dispute settlement (ISDS) mechanism. Only two of the United States 41 BITs the US-Rwanda BIT and the US-Uruguay BIT have entered into force in the past decade. This limited harvest reflects both the challenge that partner countries face in meeting the terms of the US model BIT and the difficulty that US officials face in securing congressional approval of an investment treaty. The US ratification process requiring a two-thirds vote of the Senate is prolonged and uncertain. Indeed, many US trading partners prefer to negotiate comprehensive investment chapters in their free trade agreements (FTAs) with the United States, which are similar in content to BITs but differ in the process in which the United States ratifies and implements the pact. In contrast, Chinese BITs are more numerous but much less ambitious. The large number of Chinese BITs belies their modest content, though over time the substantive provisions of these pacts have been upgraded bit by bit. The most recent iteration is the China-Japan-Korea (CJK) investment pact, which entered into force in May 2014. The recently concluded China-Korea FTA promises to further extend investment rights and obligations at the pre-establishment phase of investment in a second tranche of negotiations, which could commence in a few years. If these talks are successful, the gap between US expectations for a BIT and Chinese investment policies will narrow. Whether bilateral US-China negotiations can then reconcile the differences and resolve outstanding concerns about inward FDI policies in each country is still an open question. US officials have numerous concerns about Chinese policies that impede investment by US firms. Advantages provided to Chinese state-owned enterprises (SOEs) rank high on the list; so, too, does the application of China s antimonopoly law. Preferences accorded to domestic private firms and SOEs via subsidies and discriminatory regulations and other measures restrict competition in the Chinese market and discourage US investments in China. These practices weigh on both manufacturing firms and service providers. The latter are particularly constrained because many service activities require the firm to be established (i.e., invested) in the market where the service is provided. Chinese concerns focus primarily on the role of the Committee on Foreign Investment in the United States (CFIUS). The CFIUS reviews prospective FDI that has the potential to impair US national security and has the ability to block foreign acquisitions of US firms if it concludes that specific purchases would do so. Over the past decade, several planned Chinese investments have been cancelled to avoid CFIUS reviews or denied after CFIUS decisions. While no country would cede responsibility for safeguarding national security interests, Chinese negotiators may seek greater transparency in the criteria applied by the CFIUS in its reviews 5. United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2013: Global Value Chains: Investment and Trade for Development, 2013, Geneva. 6. For the complete text of the US model BIT, see www.state.gov/documents/organization/188371.pdf. 4 PIIE BRIEFING 15-1

and a commitment that Chinese firms will receive the same treatment as other foreign investors (that is, mostfavored nation or MFN treatment). The essays here examine these issues and offer recommendations on how to resolve outstanding differences. First, Jeffrey Schott and Cathleen Cimino analyze the recent CJK investment pact and compare it with investment provisions that the United States has developed in its model BIT and Korea-US FTA. Sean Miner and Gary Hufbauer then discuss how a US-China BIT would need to address US concerns in China regarding subsidies, other unfair advantages for SOEs, and uneven application of competition policy. J. Bradford Jensen analyzes the potential for increased trade in business services as a result of reducing investment barriers between the United States and China. Gary Hufbauer, Sean Miner, and Theodore Moran analyze CFIUS review procedures in the United States and related issues for the US-China BIT. The Briefing concludes with an overview by C. Fred Bergsten, who assesses the BIT negotiations in the broader context of US-China economic relations. 5 PIIE BRIEFING 15-1

THE CHINA-JAPAN-KOREA TRILATERAL INVESTMENT AGREEMENT: IMPLICATIONS FOR US POLICY AND THE US-CHINA BILATERAL INVESTMENT TREATY JEFFREY J. SCHOTT AND CATHLEEN CIMINO As a precursor to their free trade agreement (FTA) negotiations, which launched in March 2013, China, Japan, and Korea (CJK) signed a trilateral investment agreement in May 2012. 1 The agreement aims to set the groundwork for greater regulatory transparency, a more predicable policy environment, and a liberalized investment regime in order to facilitate intraregional foreign direct investment (FDI) (CJK Joint Study Committee 2011). The pact was subsequently ratified and entered into force in May 2014. Both Japan and Korea negotiated a basic bilateral investment treaty (BIT) with China more than 20 years ago. But the new trilateral agreement seeks to more closely align the investment standards of the three countries, including provisions on performance requirements, transparency, and intellectual property rights (IPR). These advancements are particularly important for Japan; the 1988 Japan-China BIT lacked such provisions, while the 1992 Korea-China BIT was amended in 2007 to include new obligations in these areas. 2 In the long gestation period leading up to the release of the CJK investment agreement, scant attention was given to the negotiations, given the shallow investment obligations of other intra-asian pacts. Most Western observers assumed the agreement would be little more than a political statement of good intent. However, the CJK pact is at least a small leap forward and warrants a closer look because of its content and to assess whether it stands up as a potential alternative template for Asian countries, albeit a less rigorous one than the US model. In addition, the agreement may have important implications for the incremental liberalization that China is ready or willing to accept and thus for the direction of subsequent Chinese negotiations most notably the Regional Comprehensive Economic Partnership (RCEP) between CJK and the Association of Southeast Asian Nations (ASEAN), Australia, New Zealand, and India and possibly the US-China BIT. This essay assesses the provisions of the CJK pact drawing comparisons with the highest standards of existing Chinese BITs (or FTA investment chapters) in addition to the US model BIT. The aim is to draw conclusions as to what precedents have been set by both sides that could help facilitate (or deter) the conclusion of a BIT between the United States and China in the medium term. JEFFREY J. SCHOTT is senior fellow at the Peterson Institute for International Economics. CATHLEEN CIMINO is research associate at the Peterson Institute for International Economics. They thank Josh Kallmer for his insightful comments on an earlier draft of this essay. 1. Agreement among the Government of Japan, the Government of the Republic of Korea, and the Government of the People s Republic of China for the Promotion, Facilitation and Protection of Investment, May 2012, www.mofa.go.jp/announce/ announce/2012/5/pdfs/0513_01_01.pdf. 2. See Summary of the Japan-China-Korea Trilateral Investment Agreement, Japan s Ministry of Economy, Trade and Industry, May 2012, www.meti.go.jp/english/press/2012/pdf/0513_01a.pdf; and Significantly Enhanced Protection for Korean Investors Achieved Through Amendment of Korea-China Investment Protection and Promotion Agreement, Korea s Ministry of Foreign Affairs and Trade, October 17, 2007, www.mofat.go.kr/webmodule/htsboard/template/read/korboardread.jsp?typeid=12&boar did=8588&seqno=305321. 6 PIIE BRIEFING 15-1

The CJK investment pact somewhat narrows the gap between the scope and depth of regional investment rules and the US template as set out in the US model BIT and the investment chapter of the Trans-Pacific Partnership (TPP), but overall it is not as comprehensive. In this regard, we conclude that it is not likely to serve as a concrete building block for the US-China BIT. Still, incremental progress toward liberalized investment norms within Northeast Asia could prove to be a constructive step toward closer CJK economic relations and help advance new investment opportunities for countries seeking to engage China. The hope is that further incremental convergence occurs via the investment chapters of the CJK and China-Korea FTA negotiations contingent on meaningful commitments that build on the provisions of the CJK investment pact. 3 China s track record of incremental progress toward higher standards should make it easier to forge compromises in US-China BIT talks. CJK AND US-CHINA INVESTMENT PATTERNS China has become the largest host country for FDI in the developing world and a major investment destination for Japan and Korea, whose outward FDI stock in China in 2012 was $93 billion and $51 billion, respectively (table 1). Nearly three-fourths of Japanese and Korean foreign investment goes to China s manufacturing sector. By contrast, Chinese FDI stock in Japan and Korea remains limited to just $500 million and $3 billion, respectively, or 0.3 and 2.1 percent of total Chinese Table 1 Stock of foreign direct investment (FDI) in China, end of 2012 Outward FDI stock in China Inward FDI stock from China Billions of Billions of Country US dollars Percent of total US dollars Percent of total Japan 93.0 9.0 0.6 0.3 Korea 50.6 24.9 3.3 2.1 United States 53.7 1.2 6.9 0.3 Addendum: Japan (host) and 25.5 2.5 2.8 1.4 Korea (partner) Korea (host) and Japan (partner) 3.7 1.8 41.8 26.8 Source: OECD Statistics, FDI positions by partner country, http://stats.oecd.org/; US Bureau of Economic Analysis. investment abroad. Similarly, Korean investment in Japan is limited, around $4 billion in 2012, or 2 percent of total Korean investment abroad. These imbalances gave impetus for concluding an investment agreement that could not only expand opportunities in China but also promote Chinese participation in the underinvested (in relative terms) Korean and Japanese markets. Compared with the United States, Japan and Korea invest as much if not more in China, but outward FDI stock in China accounted for 9 and 25 percent of total investment abroad, respectively, compared with 1 percent for US investors. 4 Indeed, despite the significant volume of trade between the United States and China, investment in each other s markets remains relatively low by any standard. In 2012, US FDI stock in China was reported as $54 billion with a majority in manufacturing. In contrast, Chinese FDI stock in the United States was reported as a mere $7 billion according to the US Bureau of Economic Analysis, though the Chinese Min- 3. Presidents Xi Jinping and Park Geun-hye announced the substantial conclusion of the China-Korea pact in November 2014 and a full text is expected in early 2015. The CJK FTA recently completed its fifth round of talks but is not close to the finish line. 4. Japanese investment in China has declined notably over the past year, attributed to slower growth and rising labor costs in China as well as foreign exchange dynamics, i.e., depreciating yen/appreciating yuan. See Foreign Direct Investment in China Declines, Wall Street Journal, June 17, 2014, www.wsj.com/articles/foreign-direct-investment-in-china-declines-1402980999 (accessed on December 20, 2014); and Jamil Anderlin, Foreign investment into China slumps, Financial Times, September 16, 2014, www.ft.com/intl/cms/s/0/86808f42-3d7c-11e4-b782-00144feabdc0.html#axzz3mjqrw670 (accessed on December 23, 2014). 7 PIIE BRIEFING 15-1

Table 2 Chinese outward foreign direct investment (FDI) stock in the United States, 2008 13 (billions of US dollars) Year China Ministry of Commerce US Bureau of Economic Analysis Rhodium Group a 2008 2.4 1.1 3.6 2009 3.3 1.6 5.3 2010 4.9 3.3 9.9 2011 9.0 3.6 14.8 2012 17.1 6.9 21.9 2013 n.a. 8.1 35.9 n.a. = data not available a. Sourced from Rhodium Group, China Investment Monitor, http://rhg.com/interactive/china-investment-monitor. Source: Bergsten, Hufbauer, and Miner (2014, table 13.3). istry of Commerce reported FDI in the United States as $17 billion, primarily concentrated in energy, manufacturing, and foodstuffs (see table 2). Estimates from private sources, such as Rhodium Group, seek to more accurately estimate investment flows between the two countries, accounting for other important factors like FDI routed through third countries (Bergsten, Hufbauer, and Miner 2014). Rhodium Group estimates that Chinese FDI stock in the United States was as high as $36 billion by year end 2013 (table 2). What accounts for the substantial discrepancies? In large measure, official figures do not accurately account for investment routed through third countries offering tax and other advantages; instead such investments are counted as though they come from the intermediate country. In the case of China, direct investment in the United States is sometimes routed through Hong Kong, Luxembourg, and Mauritius. Other possible explanations of the low levels between the two leading economies could include barriers to FDI such as indigenous innovation policies and intellectual property protection from the perspective of the United States (see USITC 2010). 5 US businesses cite foreign investment restrictions as one of the primary challenges to investing in China (USCBC 2014). China s Foreign Investment Catalogue includes foreign ownership restrictions in nearly 100 manufacturing and services sectors, including financial services, health insurance, agriculture, and audiovisual services. On the Chinese side, limited market access in certain US sectors like transportation, radio communications, and natural resources has created discretionary barriers, primarily in the form of political objections to mergers and acquisitions of US firms or from national security objections raised by the Committee on Foreign Investment in the United States (CFIUS) (Bergsten, Hufbauer, and Miner 2014). The US-China BIT would seek to redress some of these grievances. The CJK investment agreement attempts to address similar concerns of Japanese and Korean investors and thus may facilitate new opportunities in the Chinese market. BILATERAL INVESTMENT TREATIES The BIT offers an important tool to reduce policy barriers limiting FDI and to enhance the investment climate between two countries. The United States has 41 BITs in force, the majority of which are with developing countries, while China has more than 100, a quarter of which are with developed countries including Canada and Germany. US Model BIT The US model BIT sets out the commitments that the United States expects its partners to undertake and enforce with regard to investment policies and the protection of investor rights. 6 But only two BITs, one with Rwanda and the other with Uruguay, have been ratified in the past decade. This is in part because the terms of 5. USITC (2010, xiii) broadly defines indigenous innovation as those policies that promote the development, commercialization, and purchase of Chinese products and technologies. 6. For the complete text of the US model BIT, see www.state.gov/documents/organization/188371.pdf. 8 PIIE BRIEFING 15-1

the proposed deals are challenging for US partners and in part because the US ratification process requiring a two-thirds vote of the Senate is prolonged and uncertain. 7 Instead of negotiating treaties, US officials have primarily sought to augment investor protection through FTAs, which unlike BITs require only a majority vote in each house of Congress. That strategy has been productive with new US FTA partners like Korea and Colombia but leaves out initiatives with key countries like Brazil, China, and India. BIT negotiations are under way or under construction with China and India, but prospects are daunting given the new US demands added to the revised BIT template in early 2012 (see below). Thus, FTA negotiations in general and the TPP in particular could be an alternative, and perhaps more expeditious, channel for US investment initiatives over the near term. Within FTA investment chapters, US negotiators try to include standards from the model BIT as part of the FTA obligations. To briefly summarize, according to the Office of the US Trade Representative (USTR), the US BIT is designed to provide US investors with six benefits: 8 national treatment ( treated as favorably as the host party treats its own investors and their investments ) and most-favored nation (MFN) treatment ( treated as favorably as investors and investments from any third country ) for investors and covered investments for the full life-cycle of investment, including establishment or acquisition, management, operation, expansion, and disposition; limits on direct and indirect expropriation and procedures for the payment of prompt, adequate, and effective compensation when expropriation occurs; ability to transfer investment-related funds across borders without delay and using a market rate of exchange ; restriction of the use of performance requirements; right to employ senior managerial personnel, regardless of nationality; and right to international arbitration for an investment dispute with the host country government, with no requirement to resort to domestic courts. After extensive review, the Obama administration issued a revised US model BIT in early 2012, which calls for tougher standards. 9 These revisions will undoubtedly complicate ongoing discussions between the United States and China and other emerging markets. The major changes of the latest revision include: strong transparency obligations on regulations and other matters affecting investment and commitments to increase stakeholder and public participation; expanded labor and environmental standards with commitments not to waive or derogate from domestic labor and environmental laws, to effectively enforce such laws, and to recognize international commitments under the International Labor Organization and other multilateral agreements; and clarified specifications for state-owned enterprises (SOEs) and commitments not to impose technology transfer requirements and to encourage investor participation in the development of standards and regulations. 7. Indeed, successful negotiation of a US BIT with emerging markets like China and India in particular would require weathering intensive scrutiny from the US Senate, as evident in the recent bipartisan congressional letter to the Obama administration, from July 9, 2013, which lists a number of complaints regarding China s regulatory process, opaque and discriminatory investment restrictions, currency misalignment, indigenous innovation policies, cyber-espionage, among other issues. See Congressional Trade Leaders Flag IPR, Ag Problems Ahead of S&ED, Inside US Trade, July 11, 2013, www.insidetrade.com (accessed on April 29, 2014). This list of issues goes beyond the scope of BIT negotiations but could delay the ratification of a US-China BIT (Bergsten, Hufbauer, and Miner 2014). 8. USTR, Bilateral Investment Treaties, www.ustr.gov/trade-agreements/bilateral-investment-treaties (accessed on April 10, 2014). 9. See USTR, Fact Sheet on Model Bilateral Investment Treaty, www.ustr.gov/about-us/press-office/fact-sheets/2012/april/ model-bilateral-investment-treaty; and Johnson (2012). 9 PIIE BRIEFING 15-1

Chinese BITs Chinese BITs contain several standard features, which have evolved over time. Stephan Schill (2007) and other scholars distinguish a new generation of Chinese BITs, which began in the late 1990s and early 2000s, breaking from past BIT practice defined by more limited provisions. He argues this shift began with the conclusion of BITs with the Netherlands in 2001 and Germany in 2003, which started to conform, with some exceptions, to the standard guarantees of most treaties, including national treatment and investor-state dispute settlement (ISDS). 10 Importantly, China transitioned to BITs that offer more effective protection against political risks stemming from undue government interference with the business activity of foreign investors (Schill 2007, 2). Still, Chinese BITs retain some measure of flexibility for the ability of the state to maintain investment restrictions, through exceptions and nonconforming measures. Using the most recent Chinese BIT with Canada (ratified in 2013) as the current template, standard features of China s new generation BITs include: 11 broad definition of investment, including IPR; national and MFN treatment, conditioned on extensive exceptions; 12 protection against direct and indirect expropriation and compensation without unreasonable delay in the event it occurs; capital transfer provisions, subject to a balance of payments exception; and the right to international arbitration for an investment dispute with the host country. 13 In an extensive comparative analysis of Chinese BIT provisions, Kate Hadley (2013) concludes that foreign investor rights under Chinese law have improved and become more enforceable primarily through China s expansion of treaties with developed countries. The upgrading of standards within the CJK investment treaty complements this path (see below). China s incremental progress toward higher standards also narrows the gap between what China has done and what the United States would like it to do in the US-China BIT talks. CJK INVESTMENT PACT AND IMPLICATIONS FOR US-CHINA BIT The US-China BIT negotiations have progressed in fits and starts over the past six years. The most recent 17th round of negotiations was held in December 2014. From these extensive talks, several sticking points have emerged with respect to Chinese concessions, including: pre-establishment rights for US firms, greater transparency of investment approval processes, market disciplines and subsidies applied to SOEs, reform of policies of forced technology transfer and intellectual property protection, and ISDS procedures. 10. That these new practices coincide with China s accession to the WTO is likely no coincidence. Others have discussed the features of China s first generation and second generation BITs extensively, for example, see Hong (2009). 11. For the complete text of the China-Canada BIT, see www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/ fipa-apie/china-text-chine.aspx?lang=eng. 12. For example, the Canada-China BIT does not provide national treatment for the pre-establishment phase of investment, but rather for the expansion, management, conduct, operation and sale or other disposition of investments (Article 6). However, MFN treatment does apply to both pre-establishment and post-establishment phases of investment. This is similar to the investment chapter of the China New Zealand FTA. But in both agreements, MFN treatment is not applicable to dispute settlement procedures from other agreements (Hadley 2013). 13. For investor-state disputes, BITs generally provide investors the option of international arbitration through an ad hoc tribunal under UNCITRAL rules or through the International Center of Settlement of Investment Disputes (ICSID). In China s first generation BITs, investors were required to first submit disputes to a domestic Chinese court; further, only cases of expropriation were allowed to be submitted to arbitration (Hong 2009). However, China s post-1990 second generation BITs began to include more comprehensive dispute settlement provisions and allow for arbitration for disputes not related to expropriation. 10 PIIE BRIEFING 15-1

Bilateral talks in other forums like the US-China Strategic and Economic Dialogue (S&ED) have made slow progress in redressing related issues at the source of bilateral frictions, such as indigenous innovation and IPR policies. However, hopes were high for breaking new ground coming out of S&ED talks in July 2013 where the United States lauded several commitments from the Chinese side. 14 China agreed to negotiate market access commitments using a negative list approach, rather than its past practice of using a positive list. A negative list would open foreign investment to all sectors and industries that are not specifically excluded on the list, while positive list opens foreign investment only in those sectors that are explicitly listed. Assuming a substantive outcome of the latest round of BIT talks, negotiators plan to turn to negative list negotiations early in 2015. 15 Following the S&ED meeting, China also committed to considering pre-establishment rights, which would ensure national treatment at the preliminary phase of an investment project. China has not included either of these provisions in past BITs. These and other commitments, while encouraging, will become more meaningful when translated not only into hard obligations within China s investment treaties but also into actual policies. China s unveiling of its pilot free trade zone (FTZ) in Shanghai is widely viewed as an opportunity to test some of these commitments in practice. 16 China has made gradual commitments to more comprehensive investment obligations within its recent BITs and now has shown signs of continuing this trend within ongoing negotiations with the United States. Indeed, several substantive provisions were agreed to within the CJK trilateral investment agreement. That said, a wide gap still remains with the US standards, and China has not elevated its commitments with Korea and Japan significantly beyond the level in investment arrangements with other developed countries, namely with Canada (BIT signed 2012) and New Zealand (FTA signed 2008). Several specific provisions merit attention and are summarized here. Pre-establishment Unlike the US model BIT, the definition of investment in CJK Article 1(5) does not include the pre-establishment phase of investment. 17 Pre-establishment rights are intended to mitigate bureaucratic obstacles and discretionary requirements, for example, to ensure that a potential foreign investor can obtain visas for its personnel to enter the host country, establish a temporary office for scouting purposes, receive equal treatment from government agencies on par with domestic or third country investors, and not be subjected to performance requirements as a condition of investment (Bergsten, Hufbauer, and Miner 2014). This issue has been a major stumbling block in negotiations with the United States, as the US model BIT calls for national and MFN treatment for the entire investment process (subject to a few exceptions). This omission clearly dilutes the value of the pact for Japanese and Korean investors in China. As mentioned, China has not conceded pre-establishment rights in past BITs. 18 Within the China-Canada BIT and the China New Zealand FTA investment chapter, national treatment is afforded only for the expansion, management, conduct, operation 14. For a summary of the S&ED meeting, see Joint U.S.-China Economic Track Fact Sheet of the Fifth Meeting of the U.S.-China Strategic and Economic Dialogue, US Department of Treasury, July 12, 2013, www.treasury.gov/press-center/press-releases/pages/ jl2010.aspx (accessed on April 10, 2014). 15. Around the Globe, Washington Trade Daily 23, no. 25, December 23, 2014. 16. High expectations for the FTZ have been tempered by some skepticism. For example, the negative list released by Shanghai authorities is not seen as advancing market access substantially, as one US official explains, because it largely mirrors China s existing, very restrictive, foreign investment catalogue, and goes backwards in certain aspects. See Official: Shanghai FTZ Has Yet To Yield Major Results, Could Stall Reforms, Inside US Trade, November 14, 2013, www.insidetrade.com (accessed on April 29, 2014). 17. In the CJK pact, investment activities are defined as the management, conduct, operation, maintenance, use, enjoyment and sale or other disposition of investments. Further, an investor is defined as one that makes investments, by contrast to one that attempts to makes investments. 18. Instead, foreign investors must be granted permission to invest in an industry or sector on a case-by-case basis consistent with the guidelines of China s Foreign Investment Catalogue (Bergsten, Hufbauer, and Miner 2014). 11 PIIE BRIEFING 15-1

and sale or other disposition of investments. 19 In the China-Korea FTA announced as substantially concluded in December 2014 services and investment obligations have yet to be released, but both sides committed to launching negotiations on Pre-Establishment National Treatment and the negative list mode. 20 But to what extent China will establish a meaningful precedent in the coverage of pre-establishment rights will depend on the scope of related exceptions called nonconforming measures. Performance Requirements The prohibition of performance requirements in the CJK pact goes only marginally further than obligations already contained in the WTO Agreement on Trade Related Investment Measures (TRIMs), keeping within China s past BIT practice (see Article 7). The CJK pact covers and defines performance requirements related only to exports and technology transfer; in contrast, the US model BIT includes more explicit and extensive policies, such as indigenous innovation (see Article 6). Intellectual Property Rights The US model BIT defines investment to include IPR and mentions adherence to the WTO Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS). Notably, the CJK pact dedicates a specific article to IPR (Article 9). Specifically, the pact commits the CJK partners to protect IP and establish and maintain transparent intellectual property rights regimes, and will, under the existing consultation mechanism [ ] promote cooperation and communications among contracting Parties in the intellectual property field. However, exceptions will likely limit the effective enforcement of ISDS obligations. Specifically, subparagraph 12(a-b) of Article 15 exempts the obligation quoted above from all arbitration procedures; instead, disputes in these areas can be subject only to a competent court of the disputing Contracting Party. Transparency The CJK investment pact requires the publication of laws and regulations, and includes some language regarding incorporating public commentary, but does not specify the means for collaboration with private interest groups (Article 10). In contrast, the US model BIT contains much more specific language regarding transparency and public comment and provides more opportunity for investor involvement in consultation and collaboration (Articles 10 and 11). Specifically, the articles outline related administrative proceedings and review/appeal procedures and establish commitments that governments and nongovernment organizations will jointly develop standards and technical regulations. Temporary Safeguards Provisions Unlike the US model BIT, the CJK investment treaty includes a balance of payments exception, essentially allowing the state discretion for instituting temporary safeguard measures (Article 19). This holds over from standard practice in many developing countries BITs but may undercut the pact s commitments to free transfers as established in Article 13. 19. MFN treatment, however, does apply both to pre-establishment and post-establishment investments. Since Canada and New Zealand generally extend national treatment to all phases of investment (i.e., includes pre-establishment rights) within its BITs with third parties, the MFN provision essentially assures that like treatment is extended to Chinese investors but not vice versa (Hadley 2013). 20. Chinese Commerce Ministry Holds Press Briefing on China-ROK FTA Negotiations, press release, November 20, 2014, http:// english.mofcom.gov.cn/article/newsrelease/press/201411/20141100811629.shtml (accessed on December 30, 2014). 12 PIIE BRIEFING 15-1

Environment and Labor Standards As mentioned previously, the revised US model BIT includes new obligations to enforce domestic labor and environmental laws. Notably, the CJK pact includes commitments to environmental standards (Article 23). This is a step forward; for example, the China-Canada BIT does not distinguish a separate article in this area but includes a standard general clause recognizing it is inappropriate to encourage investment by waiving, relaxing, or otherwise derogating from domestic health, safety or environmental measures (Article 18). However, compared with the US model BIT, the level of obligation in the CJK pact is weaker and the language aspirational, basing the commitment on should as opposed to shall. Further, no comparable commitment to labor standards exists. Japan and Korea did not press China hard in these areas, so there is a substantial gap between the hard obligations that the US Congress required be included in all US trade pacts since the May 2007 accord (see Destler 2007). 21 Investor-State Dispute Settlement The CJK investment pact follows the standard practice of recent Chinese BITs in providing recourse to international arbitration for ISDS procedures. But ISDS procedures allow the state to require a disputing investor to go through a domestic administrative review procedure (not to exceed four months) before a claim can be submitted to arbitration. Exceptions to ISDS procedures are carved out for claims involving IPR, as well as prudential measures taken that relate to financial services this is a customary exception. The US perspective is that investment obligations are not generally effective without ISDS procedures with the exception of the US-Australia FTA, all US investment chapters have included ISDS. The United States would likely be flexible regarding exceptions for specified prudential measures but less so regarding issues like IPR. CONCLUSION The CJK investment agreement falls short of establishing protections as comprehensive as those in the US model BIT. That said, the pact does establish nondiscriminatory national and MFN treatment for post-establishment investment; ensures investments are afforded fair and equitable treatment and full protection and security ; ensures safeguards against expropriation and the provision of prompt and adequate compensation; and creates a functional investment dispute settlement mechanism. In particular, the inclusion of commitments to prohibit performance requirements, enhance transparency, and provide intellectual property protection, albeit limited, is progress toward a more transparent climate for Japanese and Korean investors in China. Indeed, the CJK agreement could provide new FDI opportunities for Japanese and Korean firms as the investment environment in Northeast Asia becomes more liberalized and investment opportunities shift as China moves up the value-added chain. 22 Whether investors will be able to capitalize on any advantages in the Chinese market may turn importantly on enforcement regarding IPR and technology transfer provisions. The signing of the investment agreement could also be seen as an achievement for overcoming ongoing political tensions between China, Japan, and Korea. Economic relations between the three countries had largely proceeded without the baggage of political frictions dating back over a century. However, the firewall blocking political feuds from infecting commercial relations has shown signs of breaking down. Following Japan and Korea s diplomatic quarrels over the disputed Dokdo/Takeshima Islands, Japan hinted it could roll 21. The political agreement reached between the Democratic leadership and the Bush administration in May 10, 2007, established enhanced provisions covering labor, environment, and intellectual property, among other issues, for US FTAs. 22. With increasing wages and production costs among other structural changes, the offshoring of labor-intensive manufacturing to China has slowed as China has seen a shift of investment toward high-technology areas; see UNCTAD (2013). 13 PIIE BRIEFING 15-1

back its emergency currency swap arrangement with Korea and stop buying Korean government bonds. 23 In 2010, China issued a rare earth embargo against Japan following the Daiyo/Senkaku Islands fishing trawler collision. 24 These incidents serve as a reminder that in the case of China, Japan, and Korea, the economics component in the emerging trilateral partnership must be even more substantial to overcome political frictions and wariness from historical experience. And as key competitors of each other both economically and politically in the region, the countries must tread now even more carefully in their bilateral relations. The development of these incidents could be a critical factor in the coming months and have stalled the timeline of the CJK FTA talks. As the first document on trilateral cooperation between the three countries, the investment agreement has been interpreted as the bridge for CJK FTA negotiations, with hopes that a trade deal would further elevate investment commitments. But whether the three sides will make meaningful strides toward setting liberalization precedents for the region is yet to be seen. Parallel initiatives in the region, including the China-Korea FTA talks and RCEP talks (and of course, this includes the TPP talks for Japan and possibly Korea) may take precedence in the countries respective negotiating priorities. Indeed, this has been the case for the China-Korea talks, which both sides substantially concluded at the end of 2014. In sum, given the scope of liberalization compared with the US model BIT and prospective TPP, our assessment concludes that in practice, the CJK investment pact is not likely to be a foundation for the US-China BIT. That said, incremental liberalization within Northeast Asia is an important contribution to greater economic integration in the region and likewise an important signal of China s intentions to move forward with a more ambitious investment agenda. 23. Some have considered these threats by Japan as mere cheap talk. See Tomasz Janowski, Japan hints at economic action in South Korea island feud, Reuters, August 21, 2012, www.reuters.com/article/2012/08/21/us-japan-korea-idusbre87k06h20120821 (accessed on April 10, 2014). 24. See Of metals and market forces: Is China s grip on essential minerals loosening? Economist, February 4, 2012, www.economist. com/node/21546013 (accessed on April 10, 2014). 14 PIIE BRIEFING 15-1

REFERENCES Bergsten, C. Fred, Gary Clyde Hufbauer, and Sean Miner. 2014. Bridging the Pacific: Toward Free Trade and Investment Between China and the United States. Washington: Peterson Institute for International Economics. CJK Joint Study Committee. 2011. Joint Study Report for an FTA among China, Japan and Korea. December 16. Available at www.meti.go.jp/press/2011/03/20120330027/20120330027-3.pdf. Destler, I. M. 2007. American Trade Politics in 2007: Building Bipartisan Compromise. PIIE Policy Brief 07-5 (May). Washington: Peterson Institute for International Economics. Hadley, Kate. 2013. Do China s BITs Matter? Assessing the Effect of China s Investment Agreements on Foreign Direct Investment Flows, Investors Rights, and the Rule of Law. Georgetown Journal of International Law 45, no. 1: 255 321. Hong, Guang. 2009. Scope of Arbitration in Chinese BITS: Policies & Implications. University of Miami School of Law. Available at http://works.bepress.com/guang_hong/1/. Johnson, Lise. 2012. The 2012 US Model BIT and What the Changes (or Lack Thereof) Suggest About Future Investment Treaties. Political Risk Insurance Newsletter (November). Available at www.vcc.columbia.edu/fi les/vale/content/political_risk_insurance_newsletter_-_the_2012_us_model_bit_-_nov_2012.pdf. Schill, Stephan W. 2007. Tearing Down the Great Wall The New Generation Investment Treaties of the People s Republic of China. Cardozo Journal of International and Comparative Law 15, no. 1. USCBC (US-China Business Council). 2014. USCBC 2014 China Business Environment Survey Results: Growth Continues Amidst Rising Competition, Policy Uncertainty. Washington. Available at www.uschina.org/sites/default/fi les/uscbc%202014%20china%20business%20 Environment%20Survey%20Results.pdf. USITC (United States International Trade Commission). 2010. China: Intellectual Property Infringement, Indigenous Innovation Policies, and Frameworks for Measuring the Effects on the U.S. Economy (November). Washington. Available at www.usitc.gov/publications/332/ pub4199.pdf. UNCTAD (United Nations Conference on Trade and Development). 2013. World Investment Report 2013: Global Value Chains: Investment and Trade for Development. Geneva. 15 PIIE BRIEFING 15-1

State-Owned Enterprises and Competition Policy: The US Perspective Sean Miner and Gary Clyde Hufbauer Efforts to achieve a bilateral investment treaty (BIT) between the United States and China were stalled for years, until a breakthrough at the US-China Strategic and Economic Dialogue in Washington in July 2013. China agreed to two steps long demanded by the United States, reviving the talks. First, China agreed in principle to negotiate a regime allowing US companies to invest in China on the same terms as domestic firms, known as pre-establishment national treatment. Second, China agreed to include in an eventual accord a negative list of economic sectors or industries in which foreigners would be prohibited from investing, rather than listing only those industries where foreigners could invest, potentially ending a regime that has led to confusion and arbitrary treatment by Chinese authorities in the view of US businesses. Since the breakthrough of 2013, both the United States and China have been optimistic that they can strike a deal in the near future. Both sides hope to expand investment from what seems to be an artificially low level, removing barriers to trade, establishing protections for private investors in China, and improving the investment environment in both countries. A BIT has long been desirable. Direct investment between the two countries is paltry when compared with US and Chinese investments in other parts of the world. US foreign direct investment (FDI) stock in China was $54 billion in 2012, less than 2 percent of total US FDI, 1 while Chinese FDI in the United States was $47.5 billion in 2014, less than one-tenth of China s total outward stock. 2 There is clearly pent up demand for more bilateral investment, which a US-China BIT could facilitate. Large hurdles are in the way, however. The United States feels that China s application of its antimonopoly law (AML) favors Chinese private and state-owned firms when assessing large mergers as well as alleged anticompetitive behaviors. Moreover, they feel China s state-owned enterprises (SOEs) enjoy unfair advantages ranging from cheap land, low-interest loans, subsidized inputs, to favorable regulation. The United States has backed US businesses in their pushing back against imports from Chinese firms it believes are unfairly subsidized, including using countervailing duties on products imported from those firms. A US-China BIT would have to address all these US concerns: subsidies and other unfair advantages for SOEs, and uneven application of competition policy, which US groups argue tilt the investment playing field toward China. Many experts disagree about whether state-owned and state-supported enterprises are fading in importance in the Chinese economy. But few would argue that they are going away altogether. For a successful BIT, however, China will have to address these US concerns. Sean Miner is China program manager and research associate at the Peterson institute for International Economics. Gary Clyde Hufbauer has been Reginald Jones Senior Fellow at the Peterson Institute for International Economics since 1992. 1. Data are from US Bureau of Economic Analysis. 2. Data are from Rhodium Group. 16 PIIE BRIEFING 15-1

The United States would like to see provisions in the treaty that ensure China s SOEs act in accordance with commercial considerations only. These include confining SOE behavior to normal business practices of private firms and certifying that special powers handed to SOEs are covered in the BIT, such as when SOEs control ports, ensuring they provide services equally, including for import licenses and fees charged. Making sure SOEs treat imports the same as domestically produced products and services when making procurement decisions is also a priority, as well as increasing the transparency of SOE actions. The United States would also like assurances that China s antimonopoly regulators will not unfairly target US firms when assessing anticompetitive practices. We describe these issues more in depth later. CHINA S STATE-OWNED ENTERPRISES The state-owned sector has a long history in China, but the role of SOEs has declined in relative terms since China s turn towards a market-oriented economy during the Deng Xiaoping era. Many types of SOEs coexist in China, including fully state-owned enterprises, collective enterprises, joint enterprises, and shareholding limited corporations. Local or state governments retain at least some control in almost all of these entities. However, China s State-Owned Asset Supervision and Administration Commission (SASAC) of the State Council, formed in 2003, controls over 110 of China s biggest SOEs. These SOEs earned nearly $4 trillion in 2013, a staggering amount that shows just how much influence only a few firms have in the marketplace. The local SOEs, of which there are more than 100,000, control over $13 trillion in assets. 3 State ownership was on the wane in China until 2003, when a policy change slowed the decline in the number of SOEs. The dynamics of SOE assets have also changed recently. SOEs were supposed to be concentrated in seven key sectors, as explained by Li Rongrong in 2006 4 : defense, electricity, oil and petrochemicals, telecoms, coal, aviation, and shipping. Other sectors mentioned were equipment manufacturing, automobile manufacturing, electronics, constructions, steel, nonferrous metals, chemicals, surveying, and scientific research. But according to a study by the Paulson Institute, just half of SOE assets are in one of the above listed industries. The other half are in nonstrategic sectors like restaurants, retail, and low-end manufacturing. 5 How China s AML deals with SOEs is an important matter, as it seems to be lenient with SOE operations. Article 7 of the law requires the state to protect the lawful business activities of SOEs in fields where they possess legal monopolies. This language confuses the mandate of the regulators. A report by the US Chamber of Commerce even suggests that Article 7 exempts entities under SASAC from regulation under the AML. 6 Indeed, decisions against SOEs under China s AML have been rare. This fact contributes to the claim that antimonopoly authorities in China scrutinize foreign firms more than their private domestic and state-owned competitors. ISSUES FOR THE US-CHINA BIT How can a US-China BIT satisfactorily cover SOEs and competition policy? US negotiators would like to find a way to ensure that SOEs act with only commercial considerations in mind, both at home and abroad. In 2012 the US State Department published what is called a US model BIT. This document represents the basic US policy position for negotiating investment treaties with all countries and therefore sets the benchmarks for a US-China BIT. Three provisions in the US model BIT address SOE practices: 7 3. Andrew Batson, Fixing China s State Sector, Paulson Policy Memorandum, January 2014. 4. Huanxin, Zhao, China names key industries for absolute state control, China Daily, December 19, 2006, www.chinadaily.com. cn/china/2006-12/19/content_762056.htm. 5. Batson, Fixing China s State Sector. 6. See the US Chamber of Commerce report titled China s Drive for Indigenous Innovation. 7. United States Trade Representative, 2012 U.S. Model Bilateral Investment Treaty, www.ustr.gov/sites/default/fi les/bit%20 text%20for%20aciep%20meeting.pdf. 17 PIIE BRIEFING 15-1

Delegated government authority (Article 2: Scope and coverage): The article clarifies circumstances in which a Party has delegated government authority to an SOE or another entity, to ensure that the actions of SOEs are fully covered by the BIT obligations. Government authority that has been delegated includes a legislative grant, government order, directive, or other action transferring government authority to the SOE. This happens when SOEs are in charge of important areas of the economy, like ports, and are in charge of issuing import licenses and charging fees. Domestic technology requirements (Article 8: Performance requirements): The article contains disciplines to prevent Parties from imposing domestic technology requirements (e.g., require the purchase, use or accord a preference to domestically development technology) that would advantage a Party s own investors, investments or technology. This addresses situations when a government mandates firm in certain areas of the economy, like information technology, that they must purchase domestically produced goods, like domestically produced servers rather than imported ones. Participation in standard-setting (Article 11: Transparency): Parties are required to allow investors of the other Party to participate in the development of standards and technical regulations on non-discriminatory terms. Some countries designate standards other than internationally recognized standards in order to facilitate growth of domestic industries. Non-governmental standard setting bodies are required to follow this guideline. But more language on investment-related issues is needed. US negotiators want to ensure that regulators and SOEs treat US firms in China fairly and that SOEs doing business in the United States are not acting on behalf of the government. Adding language along the following lines, drawn from Bridging the Pacific, would be useful: 8 in accordance with commercial considerations shall mean free from government influence and consistent with the normal business practices of privately-held enterprises in the relevant business or industry. In addition, language similar to the Singapore-US FTA Article 12.3(1)(c)(iv), on the abuse of a monopoly position, but extended to oligopolies, is needed. 9 So is a section on national treatment for firms of both countries to ensure that SOEs treat imports of goods and services the same as domestically produced goods and services. Treaty rules alone will not suffice to relieve the concerns of the US government and firms; effective enforcement mechanisms are also needed. Dispute settlement provisions should enable each country, and its firms, to enforce the BIT rules. The exact nature of these enforcement mechanisms must be negotiated with care. US officials and firms want to see greater transparency in SOE operations and a level playing field between SOEs and private firms. These goals can be accomplished in many ways. 8. See C. Fred Bergsten, Gary Hufbauer, and Sean Miner, Bridging the Pacific: Toward Free Trade and Investment Between China and the United States (Washington: Peterson Institute for International Economics, 2014). 9. Article 12.3(1)(c)(iv) obligates a monopoly entity to not use its monopoly position to engage, either directly or indirectly, including through its dealings with its parent, subsidiaries, or other enterprises with common ownership, in anticompetitive practices in a non-monopolized market in its territory that adversely affect covered investments. 18 PIIE BRIEFING 15-1

Impartial regulators and impartial regulation are paramount. Governments should submit their SOEs to the jurisdiction of other countries when they engage in commercial activities within the latter s jurisdiction (in other words, SOEs should not claim foreign sovereign immunity ). Covered SOEs should not be allowed to combine different lines of business more than any private company with which it competes would be allowed under domestic competition law. Financial accounts should be published in a timely manner according to International Financial Reporting Standards (IFRS). Procurement practices should be nondiscriminatory, in accordance with China s World Trade Organization (WTO) commitments (Article 46 of the Working Party Report on the Accession of China), and purchases from domestic and foreign suppliers should be disclosed periodically. Leading officers and all directors, and their past and present connections to government office, should be disclosed. Policy directives or suggestions received from government officials should be disclosed. An exemption for any SOE from any measure, regulation, or law should be published and made available on request to any Party or interested person of such other Party. Loan terms from state-owned banks and all transactions with other state-owned companies should be disclosed. Tax payments and preferences, and any incentives or subsidies received from the central, state or provincial governments, should be disclosed. 10 Parties should agree as to which SOEs will be considered public bodies for determining whether payments or concessions they make to other Chinese firms qualify as subsidies under the WTO Agreement on Subsidies and Countervailing Measures (ASCM). SOEs should be fully subject to antibribery and anticorruption laws and laws relating to the protection of intellectual property and should act in accordance with international standards. Whether US negotiators will try to insert such provisions in the BIT is unknown, but some of them are likely to be included in the Trans-Pacific Partnership (TPP). SOE INVESTMENTS IN THE UNITED STATES The perception is that China s SOEs have not invested much in the United States, or that investments from China s SOEs are not welcome. Evidence does not support these statements. Of the total of 896 investments from China in the United States, 249 were by Chinese SOEs, about 27 percent of the total. The SOE deals were generally larger than the deals of private Chinese investors, accounting for 42 percent, or over $18 billion, of total investments from China. Of the 249 SOE investments, 177 were greenfield investments, investments in new facilities and factories rather than purchases of existing companies, worth $2.5 billion, while the other 72 were acquisitions, accounting for $15.5 billion. 11 Acquisitions in the energy industry accounted for more than half the value of SOE investments. However SOEs invested across a wide variety of sectors, including aviation, information technology, health and biotech, basic materials, and real estate. The Rhodium Group broadly 10. The Canada-EU FTA (CETA) has draft provisions that limit preferential financing for SOEs. Similar provisions could be an issue in a China-US FTA. In any event, with proper disclosure, competing foreign companies that lose sales will be better positioned to bring trade remedy cases (antidumping and countervailing duties). 11. Data from the Rhodium Group s China Investment Monitor, http://rhg.com/interactive/china-investment-monitor (accessed on December 22, 2014). 19 PIIE BRIEFING 15-1

defines government-owned to include any firm with more than 20 percent government ownership. Even so, plenty of big name-brand Chinese SOEs have successfully invested in the United States. State-owned China National Offshore Oil Corporation (CNOOC) is a prominent example. Although it failed in its bid for Unocal in 2005 because of political opposition from members of the US Congress, CNOOC now has investments worth over $3 billion in the United States. CNOOC changed strategy and began investing in minority share positions and entering into joint ventures with US firms. In another case, TPCO America, a subsidiary of state-owned Tianjin Pipe Corporation made a greenfield investment in Texas of more than $1 billion. TPCO is building a massive plant for processing steel into pipes, creating more than a 1,000 jobs in the process. State-owned AVIC Automobile Industry Holding Company is a majority owner of US-based Nexteer and helped it become a powerful supplier to US auto manufacturers. Dozens of Chinese state-owned firms have invested in the United States, and each has adopted a strategy backed by experience and flexibility. INVESTMENT ISSUES WHEN SOEs DO BUSINESS ABROAD The main cause of anxiety from SOEs investing abroad is that their intentions are not transparent. Because of this opaqueness, many US observers expect worst-case scenarios, for example, that SOEs may be acting to fulfill the foreign policy goals of their government. Any host country would object to such behavior, since SOE investments could undermine its national security. Moreover, SOEs could collude in their international business deals, for example, by not bidding against each other when attempting acquisitions abroad. In 2011, China s Ministry of Commerce (MOFCOM) and SASAC signed a memorandum of collaboration to coordinate when making acquisitions abroad in order to prevent unhealthy competition. 12 Observers also speculate that SOEs don t act fairly in their home business environment, by favoring national firms over foreign firms in their procurement decisions. SASAC s market power abroad raises other issues. The European Commission decided to treat all the enterprises managed by SASAC as a single corporate entity, since the Communist Party is the controlling shareholder of all of them. This makes sense because of SASAC s latent market power: If one entity under SASAC is engaging in business in a foreign country, it seems unlikely that another SASAC entity in the same sector would enter that same market and attempt to compete against its SASAC cousin. Moreover, SASAC firms acting together can wield significant market power, for example, by refusing to purchase from certain firms or by purchasing only from each other. An underlying issue is the transparency of SOE business dealings. The US government wants to ensure that SOEs operating abroad do so with only commercial considerations in mind. It also wants to guard against collusive and unfair practices. These goals are difficult to achieve when SOE operations are shrouded in mystery. However, SOEs are required to notify the Committee on Foreign Investment in the United States (CFIUS) of all mergers and acquisitions involving US assets. This requirement ensures a high level of transparency for SOEs doing business in the United States, but it does not ensure transparency for SOE business practices in the Chinese home market. COMPETITION POLICY A competitive business environment helps deliver lower prices to consumers and fosters innovative firms. GATT and WTO rules have helped create a competitive framework for world trade but a well written and executed competition policy goes a long way to building a solid foundation for that framework. Global com- 12. See MOFCOM and SASAC Signed Cooperation Memorandum to Regulate State-Owned Enterprises Going-Out, Xinhua News Agency, August 23, 2011, http://news.xinhuanet.com/politics/2011-08/23/c_121900567.htm (accessed on December 17, 2014). 20 PIIE BRIEFING 15-1